IFRS: Impact on Hedge Accounting

IFRS: Impact on Hedge Accounting

Roundtable Key Notes

16 May 2011/ Valerie Gillis, CA, CFA

Focus for the Session

1. Introductions

2. Status update on IFRS 9 – Financial Instruments and

Hedging

3. Roundtable discussion on impact and opportunities upon

implementation of current IAS 39 with respect to hedging

4. Exploration of future hedging strategy benefits in applying

the future IFRS 9

Risk component hedging for commodity risks

Net Position hedging

Rebalancing

Effectiveness testing

©2011 KPMG Canada LLP, a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ("KPMG International"), a Swiss entity. All rights reserved.

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Joining you Today

Valerie Gillis, CA, CFA – Advisory Partner – Financial Risk Management and Complex Accounting Services KPMG LLPand Complex Accounting Services, KPMG LLP.

Ms. Gillis is a Partner in KPMG’s Advisory Services practice in Toronto with a focus on Accounting Advisory and Financial Risk Management for the banking, insurance, corporate and power and utility industries. She has been with KPMG f 15 5 t Sh f tl l t b th i h d tfor over 15 years, 5 as partner. She frequently lectures both in-house and to KPMG clients on the topics of Hedge Accounting, Foreign Currency Translation and Financial Instruments and is designated internally as one of KPMG’s global specialists relating to these matters. Most recently, Valerie is working with clients in support of their IFRS Conversion projects and application of new fair value pp p j ppportfolio hedge accounting strategies under IFRS and is closely following the IASB new developments in the area of Financial Instruments, Hedging and Impairment of Financial Instruments to help clients plan and prepare for the next wave of IFRS changes.


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Background - IASB project timetable on IFRS 9 – Future Standard on Hedging

Phase 3 Exposure Draft Standard

Hedge accounting

General – Dec. 9, 2010 General - Q3 2011 (planned)accounting (Comments were due 9 March 2011)

Currently re-deliberating and proposing certain changes to the ED.

Effective Jan. 1, 2013 (planned)

Macro Hedging – Q3 2011 (planned)

Macro Hedging - ??

Note: Phase 1 dealt with Classification and Measurement of Financial Instruments and was issued as a standard Oct. 2010 with an effective date of Jan. 1, 2013.

Phase 2 is dealing with Amortised Cost and Impairment of Financial Assets and based on comments on thePhase 2 is dealing with Amortised Cost and Impairment of Financial Assets and based on comments on the exposure draft issued Q4, 2009 and a supplement document issued Jan 2011, the joint Boards are now developing a variation of the previous proposals with an aim towards better convergence.

Some speculation whether the effective dates of all three phases will be revised.


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Currently IAS 39 – Financial Instruments: Recognition and Measurement is the effective standard which covers hedge accounting.

Discussion Point

Before we get into discussion on IFRS 9 opportunities let’s focus on current IFRSs.

Roundtable discussion:Roundtable discussion:

On transition from Canadian accounting standards to IFRS, was there a significant impact to your company’s hedging strategies as documented for accounting and to your effectiveness models?


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Potential opportunities under existing IFRS 39

Additional flexibilities in certain cash flow hedges of interest rates: Hedging component of interest rate exposure (e.g. benchmark interest rate exposure within prime based cash flows

so long as there is a reasonable economic relationship)

Ability to hedge a portion of specifically identified cash flows for a specific risk – e.g. hedge first 5 years of a 10 year fixed rate bond with a 5 year pay fixed, receive float interest rate swap.

Net investment asset hedging – opportunities around which entity holds the hedging item Need not be the entity which has the FX exposure. Could be within a sub/sister co.

Can combine non-derivative and derivative positions in one hedging relationship.

Fair Value hedges of interest rate exposure of a portfolio of financial assets or financial liabilities:g p p Ability to designate the portion hedged in terms of an amount of currency rather than individual assets (or liabilities)

themselves

Amounts designated in the scheduling of the amounts in each time bucket allows for the incorporation of expected prepayments/repricing

Moves away from the requirements that existed under previous CGAAP and existing US GAAP with respect to similarity rules of the group of hedged assets or liabilities

Aligns better with risk management approaches to hedging fair value risk

Alleviates the need for convenience tagging an interest rate swap’s variable leg in a cash flow hedge


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Discussion Point

Has your company explored any of the above IAS 39 allowed hedging strategies?

Are you commenting to the IASB on their macro/portfolio hedging ED under development?Are you commenting to the IASB on their macro/portfolio hedging ED under development?


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IFRS 9F t H d A tiFuture Hedge AccountingOpportunities

Overview of IASB Hedge Accounting Exposure Draft

Comprehensive review led to fundamental changes

Hedging ED attempts to:

Align hedge accounting more closely with risk management

Take an objective based approach to hedge accountingTake an objective-based approach to hedge accounting

Address inconsistencies and weaknesses in the existing hedge accounting model

©2011 KPMG Canada LLP, a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ("KPMG International"), a Swiss entity. All rights reserved. 9

accounting model

Overview of most significant changes

Integration of hedge accounting with risk managementAllowing as eligible hedged items:

- Aggregate exposures that contain a derivative gg g p- Risk components of non-financial instruments- Groups of items (including net positions)

Effectiveness assessment:- Current arbitrary quantitative threshold is replaced by a more conceptual approach however

wording in ED is tentatively being changed- Only prospective hedge effectiveness assessment on an ongoing basis

Rebalancing and Hedge Terminations:g g- Allowing entities to rebalance a hedging relationship by adjusting the hedge ratio and continue

hedge accounting, while prohibiting voluntary de-designationChange to dealing with Option Premiums:

Accounting for the time value component of a purchased option of which the intrinsic value is the- Accounting for the time value component of a purchased option of which the intrinsic value is the designated hedging instrument


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Discussion Point

Has your company started to assess the impact and opportunities of proposed changes to the hedge accounting standard?

If so, do you think it addresses a number of the practical challenges of aligning Treasury risk management objectives and financial reporting?


Hedging Instruments

Qualifying Hedging InstrumentsQualifying Hedging Instruments

Derivatives (includes purchased options)

Non-derivative FIs at FVTPL

Non-derivative FIs at Amortized Cost

FX hedgingDifferent from derivatives?Written option exception

Must be with an external party


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Hedged Items

Qualifying Hedged Items

Assets and liabilities at amortized cost

Unrecognized firm commitments

Highly probable forecasted transactions

IndividualGross positions

amortized cost commitments forecasted transactions

G oss pos t o sNet positions (including Net Nil in some instances)

Risk componentsAggregate exposures

Must affect P&L Must be with an external party except for certain FX risks


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Must be with an external party, except for certain FX risks

Own Use Contracts Measured as Derivatives

Accounting for a contract for a non-financial item that can be settled net in cash as a derivative:

ED t l d IAS 32 f t tED proposes to also amend IAS 32 for own use contracts:

(Contracts that are held for the purpose of the receipt or delivery of a non-financial item in accordance with the entity’s expected purchase, sale or usage requirements) y p p , g q )

that meet the definition of a derivative and can be settlednet in cash but are managed on a fair value-based risk management strategy

NEW!

Proposing to be able to measure on fair value basis rather thanas an executory contract.

Impact – may be able to avoid applying hedge accounting if both a derivative and an own use contract are both measured at fair value.


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Hedges of Groups of Items

A group of items (including net positions) are qualifying hedged g p ( g p ) q y g gitems only if:

I. It consists of items that individually qualify as hedged items

II. Managed as a group for risk management

III. For cash flow hedges of net positions only, any offsetting cash flows in the group of hedged items, exposed to the hedged risk, affect P&L in the same and only in that reporting period


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affect P&L in the same and only in that reporting period

Discussion Point

Risk component hedging – Does your company currently hedge price risk and apply hedge accounting or have you been measuring commodity derivatives at fair value? Is risk component hedging attractive or is your company moving towards managing both the hedged exposure andhedging attractive or is your company moving towards managing both the hedged exposure and the derivatives on a fair value basis?

Net Position hedging – What are your views around the proposal that for cash flow hedges of net positions that the offsetting hedged items must affect P&L in the same period?


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Effectiveness Assessment

Methodology not specifiedMethodology not specified

Can be qualitative or quantitative

Critical terms match possible as qualitative assessment

Quantitative assessment may be necessary if critical terms do not match

Risk management strategy as main source of information


Discussion Point

How do you feel the proposed changes to effectiveness assessment will affect your company? Do you foresee continuing to do quantitative analysis of hedge effectiveness using models such as regression?regression?


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Rebalancing the Hedging Relationship and Discontinuation of Hedge Accounting

Meet qualifying hedge accounting

Risk management objective remain the NO

hedge accounting criteria? same for the hedging

relationship?

Discontinue

NO

YES YESContinue hedge accounting (i.e., no voluntary de-designation)

Hedging relationship still achieves other than accidental offset? NO

Proactive balancing in expectation of

offset?

Mandatory

YES

failing effectiveness assessment

YES

yrebalancing


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Partial discontinuation may arise

Discussion Points

Do you think the proposed rebalancing requirements will align with your economic hedging objectives adequately?

What are your views around the proposed restrictions of voluntarily discontinuing hedge accounting?


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Purchased Option Hedging Strategies

Intrinsic value designated as hedging instrument

Accounting for the change in the fair value related to the time value of the optiontime value of the option

Transaction related hedged items Time period related hedged items

Accounting similar to the cash flow hedge model

Time value recorded in OCI and original time value amortized to P&L on a rational basis over the term of the hedging relationship


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term of the hedging relationship

Discussion Point

Before we get into discussion on IFRS 9 opportunities let’s focus on current IFRSs.

Roundtable discussion:Roundtable discussion:

On transition from Canadian accounting standards to IFRS, was their a significant impact to your company’s hedging strategies as documented for accounting and effectiveness models?


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Accounting for the time value of purchased options: aligned time value

The time value of the purchased option relates to the hedged item and is called the aligned time value if the option has critical terms that are perfectly aligned with the hedged item.

If the critical terms of the purchased option and the hedged item are not fully aligned an entity shall determine the aligned time value and if at inception of the hedging relationship:

The actual time value is higher than the aligned time value:

NEW! The actual time value is higher than the aligned time value:

The amount taken to OCI and the accumulated amount in AOCI are based on the aligned time value and differences are recognised in profit or loss.

The actual time value is lower than the aligned time value:g

The amount taken to OCI and the accumulated amount in AOCI are determined by reference to the lower of the cumulative change in fair value of the actual time value and the aligned time value; and any remainder of the change in fair value of the actual time value is recognised in profit or lossvalue is recognised in profit or loss.


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Discussion Point

Do you think the Board is implementing additional complexity into the standard by proposing the concept of using an aligned time value for options in assessing to what extent option premiums can be recorded in OCI for hedges of future forecasted transactions?can be recorded in OCI for hedges of future forecasted transactions?


Contact Info:

Valerie Gillis, CA, CFATel. 416 777 3030Email: [email protected]

© 2011 KPMG LLP, a Canadian limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”)of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved.

The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is y , greceived or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation.

IFRS: Impact on Hedge Accounting

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